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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.

Principal Issues: What is the tax treatment of the additional proceeds of disposition determined under paragraph 69(1)b) in respect of the purchase for cancellation of common shares?

Position: The additional proceeds of disposition is used to determine the gain from the disposition of the shares under subparagraph 40(1)(a)(i).

Reasons: Wording of the Act and previous positions.

3 July 2012

Mr. XXXXXXXXXX
TSO : XXXXXXXXXX

U. Chalupa
(613) 957-2124

2012-045082

Interaction between subsection 84(3) and paragraph 69(1)(b)

This is in response to your email of June 6, 2012, in which you requested a technical interpretation regarding the tax treatment of the deemed additional consideration received by a taxpayer by virtue of paragraph 69(1)(b) of the Income Tax Act (the "Act") in connection with a purchase for cancellation of common shares.

Unless otherwise stated, all references to a statutory section or included provision in this letter are to a section of the Act or one of its provisions.

1) Particular Situation

As we understand it, the material facts and assumptions in this case can be summarized as follows.

M Holdco and Opco are Canadian-controlled private corporations within the meaning of subsection 125(7).

M held all of the issued and outstanding shares of M Holdco.

M Holdco, B and R held all of the issued and outstanding shares of the capital stock of Opco. Those shares were voting and participating.

M, B and R were XXXXXXXXXX.

During M Holdco’s XXXXXXXXXX taxation year, Opco purchased for cancellation all of the shares of its capital stock held by M Holdco.

The parties agreed on a purchase price for the shares held by M Holdco in the capital stock of Opco of $XXXXXXXXXX. The paid-up capital and adjusted cost base ("ACB") of these shares to M Holdco were nominal.

The safe income on hand allocated to the shares of the capital stock of Opco held by M Holdco was $XXXXXXXXXX.

Consequently, M Holdco reported a deemed dividend by virtue of subsection 84(3) of $XXXXXXXXXX in its income tax return for the XXXXXXXXXX taxation year and considered that subsection 55(2) did not apply to that dividend.

Following an audit by the Canada Revenue Agency ("CRA"), the fair market value ("FMV") of shares purchased for cancellation by Opco and held by M Holdco was established as $XXXXXXXXXX.

The purchase agreement for the shares of the capital stock of Opco between M Holdco and Opco included a price adjustment clause ("PAC"). However, you are of the view that that clause is invalid. Indeed, the facts in your file would demonstrate that at the relevant time, the parties did not intend to transact at FMV.

The normal limitation period for M Holdco’s XXXXXXXXXX taxation year is XXXXXXXXXX.

2) Your Comments

You are of the view that in the event that it is determined that the PAC is invalid, paragraph 69(1)(b) would apply to M Holdco and the latter would be deemed to have received, as a result of the disposition of the shares of the share capital of Opco that it held, consideration equal to the FMV of $XXXXXXXXXX, as determined by the CRA valuation services. That approach, which would result, in addition to the deemed dividend already declared, in a capital gain of $XXXXXXXXXX for M Holdco, would be consistent with the position adopted by our Directorate in documents 2004-0086821C6 and 2004-0091781I7.

You also point out that in that situation, M Holdco could not benefit from a portion of the safe income on hand that would be allocated to the shares of the capital stock of Opco purchased for cancellation and held by M Holdco. In addition, an assessment should be issued by the CRA for the XXXXXXXXXX taxation year, which is the taxation year in which the purchase for cancellation of the shares of the capital stock of Opco held by M Holdco would have occurred.

3) Our Comments

We agree with your comments.

First, it should be noted that subsection 84(9) provides that that where a shareholder of a corporation has disposed of a share of the capital stock of the corporation as a result of the redemption, acquisition or cancellation of the share by the corporation, the shareholder will, for the purposes of the Act, be deemed to have disposed of the share to the corporation. For its part, paragraph 69(1)(b) provides that where a taxpayer has disposed of property to a person with whom the taxpayer was not dealing at arm’s length for less than the fair market value thereof at the time the taxpayer so disposed of it, the taxpayer shall be deemed to have received, as a result of the disposition, consideration equal to that FMV. In your situation, M Holdco would be deemed not to deal at arm's length with Opco by virtue of subparagraph 251(2)(b)(ii) and paragraph 251(1)(a).

On the other hand, it should be noted that pursuant to subparagraph 40(1)(a)(i), a taxpayer’s gain for a taxation year from the disposition of any property is the amount, if any, by which the proceeds of disposition exceed the total of the adjusted cost base to the taxpayer of the property immediately before the disposition and any outlays and expenses to the extent that they were made or incurred by the taxpayer for the purpose of making the disposition.

In this case, taking into account paragraph (j) of the definition of "proceeds of disposition" in section 54, the proceeds of disposition for Holdco X of the shares of the capital stock of Opco would be $XXXXXXXXXX ($XXXXXXXXXX as deemed consideration received, less $XXXXXXXXXX which represents the deemed dividend received by M Holdco by virtue of subsection 84(3)) and the ACB of those shares for M Holdco would be nominal. This would result in a gain and capital gain of $XXXXXXXXXX for M Holdco by virtue of subparagraph 40(1)(a)(i) and paragraph 39(1)(a), respectively.

Furthermore, the CRA's position is that the amount paid for the purposes of subsection 84(3) is not affected by the application of paragraph 69(1)(b).

We also agree that these adjustments should be made in respect of M Holdco’s XXXXXXXXXX taxation year and that the CRA should issue a notice of assessment in that regard.

In closing, given the circumstances surrounding this case and the fact that we have discussed with you verbally the tax consequences that could arise from a hypothetical application of the PAC, we have not considered it useful to address those aspects in this note.

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5

s. 84(3) deemed dividend based on actual redemption proceeds rather than s. 69

A CCPC ("Opco"), whose voting common shares were owned by two individuals (B and R) and by a Canadian-controlled private corporation ("M Holdco") wholly owned by a third individual ("M"), purchased for cancellation all of its shares (having nominal paid-up capital and adjusted cost base) held by M Holdco. This was a non-arm's length transaction. The safe income on hand was in excess of the purchase price, so that all of the purchase for cancellation was reported as giving rise to a deemed dividend under s. 84(3) that was not subject to s. 55(2). CRA determined that the purchase price for the shares was less than their fair market value, and that a price adjustment clause was invalid as there was no intention at the time for the transaction to occur at the shares' fair market value.

The Directorate indicated that the shares were deemed by s. 69(1)(b) to be disposed of for their fair market value. Such proceeds were reduced by the deemed dividend arising under s. 84(3), which was based on the actual amount paid rather than being modified by the application of s. 69(1)(b). CRA stated:

[T]he CRA's position is that the amount paid for the purposes of subsection 84(3) is not affected by the application of paragraph 69(1)(b).

s. 69(1)(b) adjustment generates capital gain even though larger share redemption proceeds in the 1st place would have been exempt

A CCPC ("Opco"), whose voting common shares were owned by two individuals (B and R) and by a Canadian-controlled private corporation ("M Holdco") wholly owned by a third individual ("M"), purchased for cancellation all of its shares (having nominal paid-up capital and adjusted cost base) held by M Holdco. This was a non-arm's length transaction. The safe income on hand was in excess of the purchase price, so that all of the purchase for cancellation was reported as giving rise to a deemed dividend under s. 84(3) that was not subject to s. 55(2). CRA determined that the purchase price for the shares was less than their fair market value, and that a price adjustment clause was invalid as there was no intention at the time for the transaction to occur at the shares' fair market value.

The Directorate indicated that the shares were deemed by s. 69(1)(b) to be disposed of for their fair market value. Such proceeds were reduced by the deemed dividend arising under s. 84(3), which was based on the actual amount paid rather than being modified by the application of s. 69(1)(b). Accordingly, none of the unutilized safe income on hand attributable to the shares could be utilized, and a capital gain arose to the extent of the s. 69(1)(b) adjustment.

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